Beyond promises: Mboweni should reduce issuance to demonstrate conviction

One year ago, the key risks to the fiscus were the government wage bill and capital requirements of badly run, inefficient state-owned enterprises.  Twelve months later, these risks remain. The solution to South Africa’s debt sustainability is to reduce borrowing costs by containing expenditure and boosting growth through structural reforms.

An unexpected windfall in revenues appears to be materialising on the back of the better-than-expected economic recovery. The release of the December revenue collection data has seen forecasters rush to estimate full fiscal year revenue over-runs of R35 billion to R150 billion.

This is good news. The smaller contraction in both the economy and revenues bodes well for the coming fiscal year, starting April 1, 2021, suggesting the economy suffered less erosion of productive and tax-paying capacity than feared. However, let us make no mistake.  A 7%-8% GDP decline still marks the largest contraction since the Great Depression. South Africa’s revenue may be ahead of October 2020’s expectations – but those expectations were for a very dire R300 billion shortfall from the February forecast.

It is therefore imperative that the South African government holds the line on expenditure in the 2021 Budget and through the upcoming wage negotiations. It must guard against the temptation to view the revenue over-run as a windfall that can be spent to satisfy questionable demands. Failure to do so will result in any benefits of higher revenues being completely eroded by higher borrowing costs.

With revenues running ahead of expectations, National Treasury now has an opportunity to reduce issuance – by around R2 billion per week.  This will signal to the bond market the government’s commitment to consolidate the fiscus.

In the last year the National Treasury has done an excellent job of ensuring the government had the cash available to meet its commitments through a very difficult and volatile period. Given the increased financing requirements, weekly auctions have risen from R3.5 billion per week in February 2019 to R7.5 billion/week in May 2020 and R8.6 billion/week in July 2020. Add in the Treasury Bill issuance and option take up, and South Africa is raising north of R11 billion each week from the local bond market.  It is a testament to the strength of the South African bond market that this surge in issuance could be absorbed.  However, the large amount of debt that is being issued weekly makes the market (and thus interest costs) vulnerable to changes in risk appetite.

As a result of the rising debt burden, interest costs will consume 21.2% of revenues in the current fiscal year.  In much of the world, this ratio is below 5% due to much lower borrowing costs.  Given the current large government cash balances, a continuation of the high levels of issuance would raise serious doubts about government’s commitment to further consolidation.  In such a situation, the bond market would focus on the message being sent by the debt management office rather than the contents of the Budget.

We are hopeful that the message the debt management office sends is aligned to the Budget. While bond yields have rallied by around 50 basis points in recent weeks, if the market were able to gain confidence in the commitment to control expenditure growth going forward, we estimate that bond yields could rally by a further 50 to 100 basis points.  This would quickly result in billions of rands being saved in interest costs and help lower borrowing costs across the economy as a whole – including for capital investment and infrastructure projects.  Lower interest costs will go a long way to support growth.  All we need is the bond market to believe that government is serious about consolidating debt.  Lower issuance is the communication mechanism the market understands.

Nazmeera Moola, head of SA Investments, & Adam Furlan, portfolio manager, Ninety One.